Reconciliation between Profit Statements

Marginal and absorption costing give different profit whenever inventory changes, because of how each treats fixed production overhead:

• Absorption costing carries fixed overhead in inventory (charged only when units are sold).
• Marginal costing writes fixed overhead off in full each period.

The only thing that separates the two profits is therefore the fixed overhead contained in the change in inventory. A reconciliation shows this single bridging item, proving the two statements are consistent:

$\text{Profit difference} = \text{Fixed overhead per unit} \times (\text{Closing inventory} - \text{Opening inventory})$

If the answer to a 'prepare both statements' question gives profits that differ by anything other than this amount, there is an error to find.

Start from marginal profit and adjust to reach absorption profit:

Inventory movement	Adjustment to marginal profit	Result
Increase (closing > opening)	Add fixed overhead in the increase	Absorption profit higher
Decrease (closing < opening)	Subtract fixed overhead in the decrease	Absorption profit lower
No change	No adjustment	Profits equal

So:

$\text{Absorption profit} = \text{Marginal profit} + (\text{Fixed OAR} \times \text{increase in inventory})$

or, if inventory falls,

$\text{Absorption profit} = \text{Marginal profit} - (\text{Fixed OAR} \times \text{decrease in inventory})$

Memory hook: when inventory builds up, absorption costing holds back some fixed cost in that inventory, so its profit is boosted — hence you add to marginal profit to get there.

A clear reconciliation is a short statement from one profit to the other. For example, with marginal profit $54,000, fixed OAR $9, and inventory rising by 1,000 units:

Reconciliation	$
Profit per marginal costing	54,000
add Fixed overhead in inventory increase (9 × 1,000)	9,000
= Profit per absorption costing	63,000

You can run it either way — from marginal to absorption (as above) or from absorption back to marginal (reverse the sign). Always:

• label the bridging line clearly (fixed overhead in the inventory movement);
• show the calculation (fixed OAR × change in units);
• state the direction explicitly (add for a rise, subtract for a fall).

This is exactly the check used after preparing both profit statements in the previous subtopic.

Examiners often ask you to explain the reconciling item, not just calculate it. A strong explanation says:

• The difference is not an error — both profits are correct for their method.
• It arises because absorption costing carries fixed production overhead in inventory, while marginal costing writes it off in full.
• When inventory rises, absorption costing defers some fixed overhead into closing inventory (so charges less now → higher profit); when inventory falls, it releases fixed overhead from opening inventory (so charges more now → lower profit).
• Over the whole life of the business the total profit is the same; the methods differ only in the timing of when fixed overhead is charged.

So the reconciliation demonstrates that the two methods are simply two consistent views of the same underlying results.